Liza Horvath: Ending a trust when principal runs low

Most days Ally thought of herself as a lucky girl. A great-grandmother had set up a trust for her benefit and she had been using the funds to offset the expenses of her college education. When Ally and her mother, Sara, came to see me they were looking to replace the current trustee — they said he was difficult to deal with and, because he lived out of the area, was also often hard to reach.

Trusts are all different because each one is a customized document designed to fulfil the wishes of the trustor — the person who sets up the trust. In Ally's case, her great-grandmother valued education and had accordingly set up trusts to support the educations of her heirs. Attorneys that draft trust agreements try to anticipate any circumstances that can arise during the time the trust is in action but, if a situation comes up and the document is silent on the issue, a trustee can look to the California Probate Code for direction.

Ally and Sara were not only frustrated with the current trustee's lack of responsiveness, they were also concerned that each year he would pay himself a trustee fee and would pay a tax preparer to file tax returns for the trust. Overall, the trustee and the tax professional were getting almost as much from the trust each year for their services as Ally was getting for her education.

The trust was being drained quickly and both Sara and Ally were afraid the funds would run out before Ally could complete her education. The truth was that the funds were extremely low and at the current "burn rate" all of the trust assets would be gone in less than a year. Ally did not need a new trustee, she needed to end the trust immediately so whatever money was left could be used for her education and not paid out in fees to legal and tax professionals. The trust, however, did not instruct the trustee in any way about what to do if the principal ran low.

However, Ally was in luck because although the trust did not address this issue, the Probate Code does. "If the principal does not exceed ($40,000) in value, the trustee has the power to terminate the trust," the code provides. Further, when the principal of a trust becomes low relative to the costs of keeping the trust going, the courts call this uneconomical administration and would rather see the trust terminated than continue to use up trust assets for expenses of the trust.

Ally contacted her trustee and he was initially disinclined to agree with the termination — perhaps he felt he owed a duty to Ally's great-grandmother to finish off the trust work or maybe it was as Ally thought — he just wanted the fees — but he eventually agreed to do the right thing and terminate the trust.

Ally is now using the funds as her great-grandmother intended — on her education — sans the legal and accounting bills.

Liza Horvath has over 30 years' experience in the estate planning and trust fields and is the president of Monterey Trust Management, a financial and trust management company. This is not intended to be legal or tax advice. Questions? Email liza@montereytrust.com or call 646-5262.